Do Fiscal Rules Reduce Public Investment? Evidence from European Regions

48 Pages Posted: 5 Sep 2023

See all articles by Lena Gerling

Lena Gerling

University of Münster

Leonard Mühlenweg

Free University of Berlin

Abstract

This paper analyzes the impact of fiscal rules on different public spending categories, namely public expenditure and investment, at the subnational level in Europe. Building on the notion of the deficit bias, we suspect that in the presence of fiscal rules, politicians have an incentive to reduce public spending through disproportionate cuts in investments. To empirically test this hypothesis, we focus on subnational administrative levels since budget reallocations can be expected to be pronounced at these levels and because the empirical evidence here is scarce. We introduce a new index based on partially ordered set theory (POSET) using the European Commission’s fiscal rules dataset, which allows us to analyzethe stringency of fiscal rules for different levels of government. Our balanced dataset covers 179 regions in 14 EU member states from 1995 to 2018. The empirical analysis is based on within, GMM, and instrumental variable estimations. Our empirical findings are highly robust, suggesting that a one standard deviation increase in our fiscal rules stringency index reduces overall public expenditure by up to 1.28 percent, while investment declines by more than 4 percent. The results imply that more stringent fiscal rules lead to a disproportionate reduction in public investment as compared to overall expenditure.

Keywords: Public Finance, fiscal rules, public expenditure and investment, European regions, subnational government, POSET

Suggested Citation

Gerling, Lena and Mühlenweg, Leonard, Do Fiscal Rules Reduce Public Investment? Evidence from European Regions. Available at SSRN: https://ssrn.com/abstract=4562321 or http://dx.doi.org/10.2139/ssrn.4562321

Lena Gerling (Contact Author)

University of Münster ( email )

Universitätsstraße 14-16
Münster, 48143
Germany

Leonard Mühlenweg

Free University of Berlin ( email )

Fabeckerstr. 23-25, Berlin
Berlin, DE 14195
Germany

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